A recent Australian case highlights the dangers of providing unconditional performance bonds to support international construction contracts. Contractors should consider offering conditional bonds or including protective clauses in their contracts.

Performance bonds are a common feature of many types of construction contracts, particularly in international projects. These bonds are issued by a bank directly to the employer. If the employer "calls" on the bond, the bank must pay the employer up to the limit of the bond. The contractor in turn will be obliged to repay these amounts to the bank.

Performance bonds can be conditional or unconditional. Conditional bonds are only to be paid if the employer shows that the contractor has failed to perform the contract. Unconditional bonds on the other hand must be paid by the bank once a call is made without any reference to the underlying contractual position. It is for this reason that unconditional performance bonds are referred to as "cash in hand".

The danger with an unconditional performance bond is that an employer may make a call when the contractor has good reasons for disputing that any breach of the contract has occurred. This was the case in Clough Engineering Ltd v Oil and Natural Gas Corp regarding a contract for the development of oil and gas fields off the coast of India. The Indian oil company attempted to call on an unconditional performance bond given by Clough in respect of breaches of the contract. Clough applied for an injunction against the Indian company to prevent it from calling on the bond.

The Court refused the injunction because the call had been made honestly and a dispute between the parties over breach did not prevent payment under the bond. The case was decided in Australia which has a slightly broader approach than England. In Australia, payment can in some circumstances be stopped by the Court if the parties have specifically agreed between themselves that calls will not be made unless the contractor is in breach. In England, a contractor needs to show that the call was fraudulent or dishonest before the Court will act to stop the payment.

Contractors should think seriously before agreeing to provide unconditional performance bonds. If possible, contractors should attempt to include conditions within the bond requiring any breach to be proved or certified. If an unconditional bond cannot be avoided then contractors should consider including protective measures within their contracts such as

  • Requiring notice to be given before a call is made.

  • Allowing an opportunity to remedy any breach before a call can be made.

  • Restricting the employer's right to call to specific aspects of performance such as liquidated damages.

Reference: Clough Engineering Limited v Oil and Natural Gas Corporation Limited [2008] FCAFC 136

 

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

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The original publication date for this article was 28/07/2008.